Service providers not liable as fiduciaries for excess fees under alleged kickback arrangement with robo advisor

An investment advice provider and a recordkeeper were not liable as fiduciaries for excess fees received from a robo advisor under an alleged kickback arrangement, according to a federal trial court in Illinois.

Alleged pay-to-play arrangement with robo advisor

Caterpillar engaged Financial Engines (FE) from 2012-2014 to provide automatic investment advisory services (i.e., “robo advice”) to participants in its 401(k) plan. In 2014, Caterpillar contracted with Aon Hewitt Financial Advisors (AFA) to provide investment services to plan participants. AFA subsequently sub-contracted with FE to provide the investment advisory services. In order to access the information required to furnish investment advice and implement participant investment strategies, FE, in turn, contracted with Hewitt for use of its proprietary recordkeeping system.
Charging that the fees received by Hewitt and AFA under the contracts were excessive and amounted to improper kickbacks, plan participants brought suit, alleging fiduciary breach and prohibited transactions under ERISA. Essentially, the participants alleged that Hewitt and AFA established a “pay-to-play” arrangement in which FE, in exchange for being selected to provide investment services to the plan participants, agreed to “kickback” to Hewitt and AFA a significant portion of the fees charged and collected from individual plan participants. According to the participants, the fee arrangement was unrelated to any substantive functions performed by Hewitt or AFA and improperly inflated the cost of the investment advisor services, in violation of ERISA’s fiduciary and prohibited transaction provisions.
Hewitt and AFA countered by asserting the Hewitt was not a plan fiduciary and neither Hewitt nor AFA acted as fiduciaries with respect to Hewitt’s receipt of fees or AFA’s retention of FE as a subadvisor.

Fiduciary status of service providers

The participants initially charged that Hewitt acted as a fiduciary because it exercised control over Caterpillar’s retention of FE to provide investment services. The court, however, found that Hewitt was not identified as a fiduciary in plan documents and its master service agreement with FE expressly stated that Caterpillar, and not Hewitt, retained the sole and final authority to hire FE and negotiate the terms and conditions of its service. The participants’ “conclusory” allegations that Hewitt essentially forced Caterpillar to accept FE, or that FE hired Hewitt on the plan’s behalf were not plausible (absent other evidentiary support) in light of the parties’ agreement (see also, Chendes v. Xerox HR Solutions, DC Mich (2017).
Alternatively, the participants maintained that Hewitt also acted as a fiduciary by providing investment advice for a fee. However, in addition to conceding that Caterpillar contracted with Hewitt only for recordkeeping and other ministerial services, the participants offered no evidence indicating that Hewitt provided individualized investment advice to the plan on a regular basis pursuant to a mutual agreement that the advice would serve as the primary basis for the plan’s investment decisions.
Finally, the court noted that Hewitt did not breach fiduciary duties by accepting fees from FE because it did not have discretion over the amount of its compensation. Hewitt’s arm’s-length negotiations with FE to provide transmission and technological services, furthermore, did not constitute the exercise of discretionary authority over the plan or plan assets.

AFA not liable as fiduciary for negotiating own compensation

AFA was a plan fiduciary for purposes of providing investment advice. The participants, however, did not question the quality of the investment advice, but charged that AFA breached its fiduciary duties in negotiating its own compensation to secure excess fees from Caterpillar and in hiring FE.
Initially, the court noted that, under ERISA §2510.3-21(d), an investment advice fiduciary is not deemed to be a fiduciary regarding any plan asset with respect to which it does not have or exercise discretionary authority, control, or responsibility, other than rendering investment advice for a fee. In addition, the court explained, a service provider that negotiates its own compensation with a plan fiduciary at arm’s length is not a fiduciary for that purpose. A fiduciary’s negotiation of its own compensation, the court stressed, is a non-fiduciary act
The court concluded that AFA did not unilaterally control its compensation, as Caterpillar was free to select a different service provider. Accordingly, AFA was not a fiduciary when it negotiated at arm’s length with Caterpillar and did not have control over its compensation.
AFA’s hiring of FE to provide subadvisory services also was not a fiduciary function. The court found no authority, in law or the parties’ agreements, for the participants’ assertion that the hiring of a subcontractor is an express fiduciary responsibility.
Accordingly, the participant did not establish AFA as a fiduciary for purposes other than providing investment advice. As a result, AFA could only be liable for misconduct in rendering investment advice (which was not alleged in the complaint) and not in negotiating the terms of its compensation.

Fees provided to AFA were not unreasonable

The participants also claimed that AFA violated ERISA Sec. 406(a)(1)(C) by charging and accepting excessive fees for investment advice. AFA countered that the transactions central to complaint were exempt under ERISA Sec. 408(b)(2) as services necessary for the establishment or operation of the plan for which they received reasonable compensation. Acknowledging the exemption under ERISA Sec. 408(b)(2), the participants charged that the amount of compensation received by AFA was “plainly unreasonable” in relation to the services being provided and thus, constituted an illegal kickback.
The court found the participants’ allegation to be too speculative to state a claim. Specifically, the court explained, the complaint did not include any factual allegations that the fees paid were not consistent with the fair market value of the services provided or some other acceptable metric for assessing a reasonable fee.

Service provider not liable for accepting negotiated compensation

The plan participants further charged that AFA, by receiving payments from FE of a portion of the fees paid by the plan (i.e., “kickbacks”), violated ERISA Sec. 406(b)(3) by receiving consideration for its own personal account from a party dealing with the plan. The court rejected the claim, explaining that contrary to the participants’ assertion, AFA was actually paid by the plan and its participants. Moreover, the fees paid by the plan and its participants to AFA for investment advisory services did not support an ERISA §406(b)(3) claim, the court reasoned, as service providers may not be held liable for accepting negotiated fixed compensation.